Principal Issues: [TaxInterpretations translation]
Three months before her death, Mrs. X gives a duplex to her grandson who lives in one of the two units for a year and a half before renting it. What is the adjusted cost base to the grandson of the building following the gift and change of use?
Position: General comments.
Reasons: Application of paragraphs 45(1)(a) and 13(7)(b)
XXXXXXXXXX Danielle Bouffard 2005-015775 January 26, 2007
Dear Sir,
Subject: Request for technical interpretation:
Calculation of the adjusted cost base of a duplex following a gift and change of use
This is in response to your letter of September 27, 2005, requesting our opinion on the above subject. We apologize for the delay in responding to this request.
Mrs. X owned a duplex, 2/3 of which was her principal residence and 1/3 of which was rented to a third party. Mrs. X made a gift of the duplex to her grandson. At the time of the gift, the building had a fair market value ("FMV") of $200,000. Three months after the gift, Mrs. X died. In Mrs. X's final return, a capital gain, resulting from the disposition of the property on the gift to her grandson, was declared on the rental portion of the duplex (i.e., 1/3 of the area) and the principal residence exemption was claimed on the portion of the capital gain calculated on the portion of the building inhabited by Mrs. X.
The grandson occupied the portion of the duplex previously occupied by Mrs. X for a year and a half and then rented it out. At the time of the change of use from residential to rental, the FMV of the building was $250,000.
You have detailed the calculation of the capital gain resulting to Mrs. X from the gift of the building as well as the calculations relating to the adjusted cost base ("ACB") of the building to the grandson at the time of the gift and the change of use.
Question
Are the calculations for the ACB of the building provided in your request accurate?
Our Comments
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of the Canada Revenue Agency (the "CRA") not to issue written opinions on proposed transactions otherwise than through advance rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate tax treatment, that determination is made first by our Tax Services Offices as a result of their review of all facts and documents, which is usually performed as part of an audit engagement. However, we can offer the following general comments. These comments may, however, under certain circumstances, not apply to your particular situation.
Paragraph 69(1)(b) of the Income Tax Act (the "Act") deems a taxpayer to have received proceeds of disposition equal to the FMV of the property on its disposition where the taxpayer disposed of the property to a person with whom the taxpayer was not dealing at arm's length for no proceeds or for proceeds less than the FMV of the property at the time of disposition, or where the taxpayer disposed of the property to a person by way of gift inter vivos. Paragraph 69(1)(c) provides that a taxpayer who acquires a property by way inter alia of gift, is deemed to acquire the property at its FMV. In the situation submitted, Mrs. X is deemed to have disposed of the building and land (i.e., the duplex) for a consideration equal to the FMV and her grandson to have acquired it at that FMV.
Section 54 defines the ACB of a depreciable property (for example, a housing unit held for rental purposes) as the capital cost to the taxpayer of the property at that time. In the case of property other than a taxpayer's depreciable property (for example, a housing unit that is the taxpayer's principal residence), it is the cost of the property plus or minus certain adjustments pursuant to section 53.
Regardless of the method used to allocate the acquisition cost and proceeds of disposition of the building to the leased portion (generally based on the total area of the building), we are of the view that it is generally reasonable to allocate the acquisition cost and proceeds of disposition of the land using the same method. Of course, this method must be reasonable in the circumstances. Consequently, when the duplex (building and land) were gifted, Mrs. X was able to benefit from the principal residence exemption on the portions of the building and land that were considered, according to the facts, to be her principal residence. For present purposes, we have assumed that the duplex has two separate housing units, one of which, representing 2/3 of the total surface area, was ordinarily inhabited by Mrs. X and then by her grandson after the gift ("Housing Unit 1") and the other unit (Housing Unit 2), representing 1/3 of the surface area, was always held for rental purposes.
Paragraph 45(1)(a) provides, inter alia, that for the purposes of subdivision c (i.e., sections 38 to 55, with subdivision c dealing with taxable capital gains and allowable capital losses), a taxpayer who has acquired property for some other purpose, has commenced at a later time to use it for the purpose of gaining or producing income (a "change in use") is deemed to have disposed of that property at that later time for proceeds equal to its FMV at that later time. That taxpayer is also deemed to have immediately thereafter reacquired that property at a cost equal to that FMV. That deemed disposition of the property may give rise to a capital gain or loss. As stated above, the grandson having lived in unit 1 for a year and a half, could benefit from the principal residence exemption on that unit (building and land portion) to reduce the capital gain resulting from that deemed disposition.
Paragraph 13(7)(b) provides, inter alia, that for capital cost allowance purposes, where a taxpayer, having acquired property for some other purpose, has begun at a later time to use it for the purpose of gaining or producing income, the taxpayer shall be deemed to have acquired it at that later time at a capital cost to the taxpayer equal to the lesser of the amounts set out in subparagraphs 13(7)(b)(i) and 13(7)(b)(ii). In a situation where the FMV of the property exceeds the cost, one-half of the gain resulting from the application of subparagraph 45(1)(a)(iii) may be added to the capital cost of the property for the purposes of sections 13 and 20 provided that the taxpayer has not deducted an amount under section 110.6 in respect of the gain.
In the situation described here, the method of calculating the cost of housing unit 1 and the cost of housing unit 2 to the grandson at the time of the gift (Calculation 1) and at the time of the change of use (Calculation 2) seems to us to be correct for the purposes of calculating the capital gain. However, for capital cost allowance purposes, the capital cost of housing unit 1, which has undergone a change of use, should be calculated taking into account the provisions of paragraph 13(7)(b). Using the figures provided in Calculation 2, the capital cost of Housing Unit 1 and Housing Unit 2 would be $150,000 and $66,666 respectively.
These comments are not advance income tax rulings and do not bind the CRA with respect to any particular factual situation.
Best regards,
Alain Godin
For the Director
International Operations and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch